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Bush Tax Cuts Made Sub-Prime Fiasco Possible

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The Bush tax cuts have created a scenario in which the lions's share of the benefit have gone to rich individuals furthering the gap between the rich and the other economic classes.  The reduction and elimination of the estate tax puts even more wealth into the upper 1% of families.  As a result, rich individuals have increased their wealth geometrically.  However, Bush did not give any rate cuts to corporations.  Let's analyze this. 

Supply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created using incentives for people to produce (supply) goods and services, such as adjusting income tax and capital gains tax rates. This can be contrasted with the classic Keynesian economics (or "demand side economics"), which argues that growth can be most effectively managed by controlling total demand for goods and services, typically by adjusting the level of Government spending. Supply-side economics is often conflated with trickle-down economics, a derogatory term given to right leaning economist's views by political opponents (source: Wikipedia).  The key phrase is: using incentives for people to produce (supply) goods and services.  The people who produce goods and services are businesses most of which are corporations.  Labor produces goods and services with the oversight of corporate executives.

If Bush were to be true to supply side theory, the tax incentives would have been given to the corporations and unincorporated businesses.  Tax cuts could have been easily targeted to businesses.  The big lie in all of this is that there was only a giveaway to rich individuals and not businesses.  One could argue that a reduction in business taxation coupled with a reduction in middle class taxation could stimulate the economy.  That concept is neither supply side or Keynesian economics.  I would label this as a hybrid so let's call this concurrent tax cut Drobnyian economics.  In this economic climate, businesses and the consuming classes need help and this measure would be a reasonable approach coupled with an increase of taxes for the rich. 

There was no intent to provide economic substance to the giveaways to the rich authorized by Bush.  As demonstrated above, there is no supply side benefit to these tax cuts.  Bush falsely gives the argument that the wealthy families will somehow reinvest their tax savings into business ventures.  The fact is that the increase in family wealth afforded by these tax cuts were put primarily into securitzed funds.  In the 90's, excess wealth was put mostly into venture capital funds.  These VC funds do provide some possible supply side benefit in that VC funds incubate new businesses.  However, the NASDAQ collapse of 2000 put an end to all of that.  The real problem of the 90's was that too much wealth was searching for too few deals.  Accordingly, the false values attributed to the dot.com companies was the precursor to the 2000 collapse which did not have any major affect on the assets of the working class.

The corporate scandals of 2001-2003 did impact the working class and their retirement plans.  However, the Bush tax cuts put a lot more money into the coffers of wealthy families who did not reinvest these amounts into VC funds or businesses.  These wealthy institutional investors needed to park their money into something that would earn more than the secure fixed income securities.  But, they were not going to take any more risk in the tech heavy VC funds.  This time, the investment banking community had an opportunity to come up with an idea that they perceived to be less risky.  And that idea was to create funds that focused on the growing mortgage industry.  Just as was the case in the 90's, these funds had too much money searching for too few deals. 

In order to increase demand for refinancing mortgages, these groups came up with the sub-prime concept.  These below market loans induced people to refinance their homes with the false premise that this interest savings would be permanent.  In fact, the savings on the front end of the new mortgages was transferred to the back end of the short term mortgage.  When the renewals began to take affect, people were suddenly faced with monthly payments they could not afford.  Furthermore, the people who refinanced their homes at these favorable rates generally spent their reduced payments without understanding the consequences.  They did not have any savings to offset those increases.

As was the case with the dot.com collapse, the inflated demand for low interest loans created a false valuation in the real estate market.  Prices of homes were inflated because of the easy access to money.  The fund managers did not truly understand that the collateralized value of the homes was very much overstated.  Traditional mortgage collateral is usually greater than the loan amount.  When the crunch came and prices went down, suddenly foreclosures would not be able to pay off the mortgages.  As a consequence, almost every sub-prime loan resulted in a loss to these funds that is now being reported by all of the big investment banking firms. 

The dot.com collapse came after the investment firms had earned enormous amounts of money in the stock market boon.  These firms ended up with a substantial net gain from the tech boon.  That was not the case with the sub-prime funds.  There was a catastrophic net loss to the investment bankers.  These banks are now seeking billions of dollars from the overseas market to save their businesses.  This is not the case for the homeowners who were victimized by these very wealthy funds that were in large part a consequence of the Bush tax cuts. 

We need a tax and monetary policy that is not based upon hunches and false economic theory.  We need some real experts to take on the task of saving this economy.  I would be open to being Secretary of the Treasury. 

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Sheldon Drobny was the co-founder of Nova M radio and Air America Radio. He has supported many philanthropic causes. Mr. Drobny specializes in business and tax matters and is admitted to practice before the U.S. Tax Court as a non-attorney. Less (more...)
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